Rational exuberance

Trevor Greetham

19 January 2018

Global stocks have risen in eight of the last nine years and investor sentiment is frothy. However, the length of this bull market is explained by the length of the economic expansion, something we don’t see ending soon.

In the last 160 years, only three US business cycle expansions have lasted more than eight years. The current cycle will outstrip the 1960s in April this year and move into second place, challenging the record set by the 10 year expansion of the 1990s.

The comparison with the 1990s is apt. The decade long slowdown in Japan caused a slide in commodity prices and low inflation meant monetary policy stayed loose for many years. It all ended with the ‘irrational exuberance’ of the dotcom bubble.

This time around a slowdown in China has kept commodity prices down, interest rates are even lower than in the 1990s and equity market valuations are getting expensive again.

Outrageous valuations for assets with a passing connection to certain technologies (from joke cryptocurrencies to juice manufacturers adding Blockchain to their name) are particularly reminiscent of the dotcom boom.

However, strong growth trends and low interest rates in developed economies suggest the business cycle still has further to run.

America’s late cycle tax cuts could super-charge their economy in 2018 and trigger an unwelcome rise in inflation. Highly-valued stock markets might correct on aggressive interest rate rises. But with US interest rates at or below the rate of inflation and other central banks printing money it’s too early to worry about recession risks and we would probably buy such a dip.

There’s also a good chance that another deflationary shock from China comes along later this year, pushing commodity prices and inflation down again. Beijing has been tightening policy, house prices have stopped going up and hard data looks to be rolling over.

Against such a backdrop, this could well become the longest expansion on record. For the time being strong growth, low inflation, low interest rates and tax cuts add up to make the case for this being rational, rather than irrational exuberance.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.